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How to Improve Compensation Committee Effectiveness

Finding the time and resources for board and committee development is an ongoing challenge.  But enhancing the effectiveness of your Compensation Committee can be done with a few key actions.  This blog and ones that follow will address:

  • Setting a workable Committee calendarCompensation Committee Calendar
  • Selecting membership
  • Continuing education on executive compensation

The beginning of the year is a great time to update or set up a calendar for your Compensation Committee.  Committee responsibilities and activities need to be spelled out in advance and scheduled throughout the year to:

  • Balance the Committee’s workload
  • Allow sufficient time for review before decisions are required
  • Ensure that decisions are well-timed for effectiveness as well as meeting any regulatory requirements

The first step in building the calendar is listing and grouping activities.  You may be surprised at how many issues need to be addressed when you write them all down.  Our basic categorized list includes:

  • Compensation Philosophy Statement
    • This roadmap for guiding Committee decisions should be reviewed at least annually.
    • If you don’t have one, you would be surprised how helpful having written principles can be.
    • Market and Peer Group Review
      • Update the peer group for relevancy.
      • Gather compensation data from surveys and proxies.
      • Monitor performance versus peers.
      • Performance and Salary Review
        • Board/Committee review of CEO performance; and CEO review and report on other senior officers.
        • Committee review of CEO salary and adjust based on market/peer pay levels and executive job performance.
        • Committee review of CEO recommendations for other senior officers.
        • Annual Incentive Plan
          • Update plan in terms of participation, payout ranges, objectives, weights, and performance ranges.
          • Review performance and potential payout levels at mid-year.
          • Complete end-of-year review and approve payouts.
          • Long Term Incentive Plan (if you use stock)
            • Review existing grants and remaining share reserve.
            • Determine any need for updating plan and/or share reserve.
            • Determine new grant (type of grant, total shares, terms, CEO allocation).
            • Review and approve CEO recommendation for grants to other officers.
  • Compensation Risk Assessment
    • Conduct at least annually – ideally just after the end of the year so the Committee can look back at the prior year and plan for the year just beginning.
    • Director Compensation
      • Determine frequency of review (we recommend an annual review; but at least every third year as a minimum).
      • Conduct review and recommend changes to Board.

Of course, companies participating in government programs like TARP or those who are required to report to the SEC have a number of other requirements and activities that we won’t try to cover here.  Suffice it to say that these requirements are a significant expansion of the previous list.

Filling out the calendar is best done using a grid with the major categories of work down the left side of the calendar, and the months across the top.  This approach allows you to schedule the items in each category in logical order as well as look at the volume of Committee work in each month.

Finally, this is a task best completed by the Committee Chair, CEO, and outside compensation consultant if you have one.  You may also want your CFO and Chief Human Resources Officer involved if they interact directly with the Committee.

Please add comments below, and if you want to know more about how we can help, call me at 919-644-6962 or ask us to contact you at http://matthewsyoung.com/contact.htm.

How to Improve Executive Compensation Committee Effectiveness – Membership Selection and Committee Structure

In a previous blog entry, I talked about improving Executive Compensation Committee Effectiveness by setting up an annual Committee calendar to balance workload, set priorities, and ensure timely and effective decisions.

This follow-on blog highlights four important elements for effectiveness from the standpoint of Committee membership, structure, and decision-making authority:

  • Characteristics of effective committee members
  • Appropriate committee size and turnover
  • Balancing other committee assignments
  • Assigning sufficient authority

 

Characteristics of Effective Committee Members

Some Director backgrounds are more appropriate than others for the Compensation Committee.  Candidates with formal corporate management experience or service as professional directors tend to have a better perspective for dealing with complex compensation issues.  Directors with entrepreneurial or smaller company experience may not have faced these kinds of issues before.

 

Appropriate Committee Size and Turnover

Our experience shows that the Compensation Committee needs at least three independent members but typically not more than five.  Decision-making is streamlined with a smaller committee; but don’t get so small that you limit important interaction and having a range of perspectives that ultimately builds strong consensus.  Also, you should change no more than one-third of the committee’s members in a year.  Otherwise, you lose “institutional memory” and valuable experience and expertise that takes a while to develop.

 

Balancing Other Committee Assignments

Because of the importance placed on the governance of executive compensation, membership on the Compensation Committee should be a director’s primary committee assignment.  If at all possible, don’t place directors on both the Compensation and Audit Committees.  While you want your best directors on your most critical committees, you don’t want to stretch them too thin.

 

Assigning Sufficient Authority

And finally, all Boards of Directors should take the time to determine what level of authority the Compensation Committee will hold.  We believe that Compensation Committees are most effective when the Board assigns them specific decision-making authority.   Where full Board voting is desired or required, the Committee should always bring a specific recommendation that the Committee has developed and fully supports.

If you would like a sample Compensation Committee Membership Profile, we would be happy to send you one.  Complete the following request form:

No Fields Found.

 

How to Improve Compensation Committee Effectiveness

Finding the time and resources for board and committee development is an ongoing challenge.  But enhancing the effectiveness of your Compensation Committee can be done with a few key actions.  This blog and ones that follow will address:

  • Setting a workable Committee calendarCompensation Committee Calendar
  • Selecting membership
  • Continuing education on executive compensation

The beginning of the year is a great time to update or set up a calendar for your Compensation Committee.  Committee responsibilities and activities need to

be spelled out in advance and scheduled throughout the year to:

  • Balance the Committee’s workload
  • Allow sufficient time for review before decisions are required
  • Ensure that decisions are well-timed for effectiveness as well as meeting any regulatory requirements

The first step in building the calendar is listing and grouping activities.  You may be surprised at how many issues need to be addressed when you write them all down.  Our basic categorized list includes:

  • Compensation Philosophy Statement
    • This roadmap for guiding Committee decisions should be reviewed at least annually.
    • If you don’t have one, you would be surprised how helpful having written principles can be.
    • Market and Peer Group Review
      • Update the peer group for relevancy.
      • Gather compensation data from surveys and proxies.
      • Monitor performance versus peers.
      • Performance and Salary Review
        • Board/Committee review of CEO performance; and CEO review and report on other senior officers.
        • Committee review of CEO salary and adjust based on market/peer pay levels and executive job performance.
        • Committee review of CEO recommendations for other senior officers.
        • Annual Incentive Plan
          • Update plan in terms of participation, payout ranges, objectives, weights, and performance ranges.
          • Review performance and potential payout levels at mid-year.
          • Complete end-of-year review and approve payouts.
          • Long Term Incentive Plan (if you use stock)
            • Review existing grants and remaining share reserve.
            • Determine any need for updating plan and/or share reserve.
            • Determine new grant (type of grant, total shares, terms, CEO allocation).
            • Review and approve CEO recommendation for grants to other officers.
  • Compensation Risk Assessment
    • Conduct at least annually – ideally just after the end of the year so the Committee can look back at the prior year and plan for the year just beginning.
    • Director Compensation
      • Determine frequency of review (we recommend an annual review; but at least every third year as a minimum).
      • Conduct review and recommend changes to Board.

Of course, companies participating in government programs like TARP or those who are required to report to the SEC have a number of other requirements and activities that we won’t try to cover here.  Suffice it to say that these requirements are a significant expansion of the previous list.

Filling out the calendar is best done using a grid with the major categories of work down the left side of the calendar, and the months across the top.  This approach allows you to schedule the items in each category in logical order as well as look at the volume of Committee work in each month.

Finally, this is a task best completed by the Committee Chair, CEO, and outside compensation consultant if you have one.  You may also want your CFO and Chief Human Resources Officer involved if they interact directly with the Committee.

Please add comments below, and if you want to know more about how we can help, call me at 919-644-6962 or ask us to contact you at http://matthewsyoung.com/contact.htm.

How to Do a Compensation Plan Risk Assessment

The SEC, US Treasury and jointly for banks the Federal Reserve, OCC and FDIC in a joint agency statement have made risks in compensation plans a high priority and point of emphasis.  Furthermore, SEC proxy disclosure requirements for 2010 require an explanation of the relation between compensation plans (primarily incentive compensation) and risks that may be more encouraged due to motivations caused by such compensation plans.  Specifically, these regulatory agencies want to identify and eliminate compensation plans that “create risks that are reasonably likely to have a material adverse effect on the company.”

Matthews, Young – Management Consulting has worked with several clients assisting them with the necessary process and review of Compensation Policy and Plans, including a number of community banks participating in the TARP program who must comply with similar regulatory requirements.  Randy McGraw, a Senior Consultant with our Firm, collaborated with me to layout the specifics of Compensation Plan Risk reviews.

Scope and Timing of our Review

Our assessment of compensation programs requires a review of all compensation plans and practices (with emphasis on incentive compensation) to ensure that they do not encourage participants:

  • To take unnecessary and excessive risks which threaten the value of the company.
  • To manipulate reported earnings to enhance compensation.
  • To focus attention exclusively on short-term results at the expense of longer term performance that adds value to the institution.
  • For organizations taking TARP funds from the Treasury, at least every six months, the Committee and Senior Risk Officer (SRO) review all employee compensation plans related to excessive risk, manipulation of earnings, and short-term over long-term results.  The Committee is required to limit and/or eliminate any plan features that encourage such behavior.
  • For TARP recipients, SEC reporting companies, and all financial institutions, at least once every fiscal year, the Committee and SRO, in addition to review, discuss results and prepare a narrative description of findings and actions taken on any adverse findings in review.
  • For TARP recipients, within the first 120 days of the end of the fiscal year, the Committee prepares a narrative report describing Committee meetings, discussions, and actions.  The report must be submitted to both U.S. Treasury and primary regulator  For SEC reporting companies, results of review are reported in the proxy statement.

Key Elements of our Analysis

We will look at an overview of total compensation to ensure that:

  • There is a balanced mix of pay elements (base salary, annual cash incentives, long-term equity award incentives)
  • Base salaries are sufficiently competitive to avoid undue emphasis on earning incentives in order to earn reasonable cash compensation.
  • Potential incentive levels achieved from short-term and long-term plans are balanced to ensure sufficient focus on long-term results.

For short term incentive compensation, our review will be focused to ensure:

  • Reasonable number of participants.
  • Maximum incentives are capped and potential incentives are reasonable.
  • Performance measures require a balance between earnings, return, revenue or asset growth, operating efficiency, and asset quality or other risks.
  • Performance measures support achievement of operating as well as strategic goals.
  • Performance measures strengthen teamwork as well as match a participant’s areas of accountability.
  • Incentives do not create a conflict of interest for officers with compliance and audit responsibility.
  • Whether plans contain a claw-back provision which has been communicated to participants.

For long term incentive compensation (as applicable), our review will be focused to ensure:

  • Reasonable number and category of participants.
  • Stock overhang and run rate are in line with prevailing market practice.
  • There is balance between appreciation-oriented (options) and full-value (restricted stock) grants; as well as balance in full-value grants between time-vested and performance-based grants.
  • Option grant exercise price is at or above fair market value; and re-pricing is prohibited.
  • Vesting and performance periods are sufficient to emphasize multi-year service and performance.

Review Methodology

Bank regulations require that the Compensation Committee meet with the Bank’s designated Senior Risk Officer (SRO) to discuss relevant issues; and suggest using an outside compensation advisor to facilitate the compensation review.  This approach is also recommended for other types of organizations.  Our recommended methodology is as follows:

  • Matthews, Young – Management Consulting will assess compensation plans and practices based on information provided by client.
  • Matthews, Young – Management Consulting will draft a letter that describes our review and findings along with any recommendations for change and provide this letter to the SRO.  With client’s input, we prepare a table summarizing key terms of all incentive compensation plans specifically Plan Name, Plan Purpose, Participant List, Administrative Responsibility, Performance Measures and Incentive Payout Potentials.
  • SRO reviews our letter; assesses the potential risk created by compensation in the following risk areas: Credit, Market, Liquidity, Operational, Legal, Compliance, and Reputation.
  • SRO then prepares their own letter to the Committee summarizing the review process and findings.
  • Compensation Committee meets with outside consultant and SRO, reviews both letter and reports, identifies any actions required to modify plans, and documents meeting activities.

We are currently offering a free telephone consultation to further discuss the regulatory requirements and risk review process.  Please contact us if you would like to discuss your compensation plans and an assessment of the risks they may pose to your company.  Call 919-644-6962 and ask for David Jones, Randy McGraw or Tim O’Rourke.  You can also complete the request form at http://matthewsyoung.com/risk_review_contact_landing.htm.

A Creative Answer to Implementing Executive Stock Ownership Guidelines

There is a clear trend among companies to strengthen the linkage between shareholder and executive interests.  Many companies are responding to this trend by evaluating the effectiveness of having stock ownership and/or stock retention guidelines for their executive officers.

We observe that implementing such guidelines in the current economic environment can be challenging for these executives.  Since executive cash compensation is flat or increasing only slightly, achieving stock ownership requirements can represent a greater burden than in the past.

However, these difficult times also present a partial solution.  Many companies decided not to give salary increases to key executives for 2009 and, some cases, 2010 as well.  Hopefully, those companies are having better financial results this year, are concerned that executive salaries may trail the market, and are considering giving an additional salary increase beginning in 2011 – say five percent on top of whatever a regular raise might be.  Herein lies the opportunity to address some of the challenge of increasing executive stock ownership.

Instead of granting the additional raise, consider an equivalent value in Restricted Stock Units (RSU’s) with a reasonably short restriction period (e.g., two years).  Since the salary increase is an annuity as long as the executive is employed, then the company would grant the same dollar value in RSU’s every year.   RSU’s also offer an interesting feature that is not available with Restricted Stock grants – RSU’s can be voluntarily deferred beyond the restriction period as long as the executive complies with IRS Code Section 409A requirements related to the deferral.

This approach offers several benefits both to the company and to the recipient:

  • The executive defers income taxes until actual shares are finally received at the end of the restriction period, including the voluntary deferral period.  Thus, the executive accrues more shares than if the additional salary were used, on an after-tax basis, to buy stock.
  • The company’s stock ownership guidelines would give credit for RSU’s that have been granted and not yet converted into actual shares.  By using the voluntary deferral procedure, the executive can count all RSU’s towards meeting stock ownership guidelines as well as postpone income tax.
  • There is also the option to take cash in lieu of shares (or a portion in cash to pay income tax and the remainder in shares) at the end of the deferral period, or to defer the cash payout as long as the executive complies with IRS Code Section 409A rules.
  • The company does not have to issue actual shares until the end of the voluntary deferral period.
  • Since this will be an ongoing program of annual grants and increasing stock ownership among executives, there is also a pretty nice story to tell shareholders.

These are challenging times for addressing executive compensation issues.  But maybe this is one of those instances of being handed “lots of lemons”, but using the opportunity to “make some lemonade”.

Market Information Helps With Tough Salary Planning Decisions.

In a recent blog, we talked about taking a broader perspective when planning salary increases for 2011.  We were also waiting for better forecasts for 2011.  More comprehensive reports are now available and suggest the following:

  • We are seeing a clear increase in the percent of employers and banks granting pay raises.  While two-thirds of employers gave increases in 2009, nearly 85% gave increases in 2010.  And we expect this percentage to increase for 2011.
  • U.S. employers report they are budgeting  average raises of 3.0% in 2011, as are banks and other financial institutions.
  • The middle 50% of employers report  2011 salary increase budgets between 2.6% and 3.5%.
    • Again, financial institutions are very similar – ranging from 2.5% to 3.2%.
  • History shows some fluctuation between forecast and actual increases among general industry as well as financial institutions:

Industry

2008 Actual

2009 Forecast

2009 Actual

2010 Forecast

2010 Actual

2011 Forecast

All

3.9%

3.9%

2.2%

2.8%

2.7%

3.0%

Financial

3.9%

3.9%

2.3%

3.0%

2.8%

3.0%

If this fluctuation between projected and actual continues, banks may give less than 3% in actual raises in 2011.

In addition to the broader questions we raised in our previous blog, budgeting for pay raises eventually comes down to practical questions:

  • What’s your best estimate of what the competitive market will do?
  • How long has it been since your last round of raises?
  • What can you afford to do, considering your expected financial performance?
  • And as we pointed out in an earlier blog, how do your overall salary levels stack up against current market salaries?  If you haven’t checked the market lately (perhaps because you didn’t grant raises), then you lack important information on competitiveness and whether (a) you are still paying competitive rates or (b) a gap has opened between your organization’s salary levels and the market.

We have also seen a couple of other techniques to mitigate the cost of salary raises:

  • Postpone the effective date of raises until later in the year.  Granting raises on July 1 rather than December 1 saves half the expense for the calendar year.
  • Grant merit pay in a lump-sum to employees high in their salary ranges but performing at a superior level.   While the lump-sum payment is a current expense, it does not increase the employee’s future pay rate.

These are challenging times for compensation planning.  If we can be of help, please don’t hesitate to contact the firm at (919) 644-6962 or me direct at (404) 435-6993.

Effective Salary Planning Isn’t Just About Budgeting for Raises. And It’s Not Too Early to Start Planning for 2011.

We have talked to lots of banks, credit unions and other organizations that chose to forgo or greatly reduce salary increases in 2009 and 2010 due to significantly lower company earnings.   While it’s only common sense that you can’t raise salaries if there isn’t the money to pay for them, the risk of your best talent seeking other jobs grows as time passes without seeing a raise.

To add to the challenge, data on actual raises in 2010 and early forecasts for 2011 paint a blurred picture at best.  So what do you do when there isn’t much useful market or competitor data to guide you?  The best approach in these trying times isn’t really different from what it’s always been – only more challenging.  Instead of thinking of your salary increase budget in a vacuum, think in terms of broad salary planning for your anticipated workforce.  For example, ask yourself the following questions:

  • Are you experiencing turnover in positions that you can afford not to fill?  Lower headcount could free up some salary expense that could fund raises for others.
  • If you are filling vacant positions, will you be able to recruit qualified candidates at salary levels below those paid to employees that left?  This may be especially true in cases where turnover was due to retirement of long service employees.
  • Do you expect revenue growth that can be generated without headcount increases?  Will this revenue growth be profitable growth evidenced by increased earnings?
  • Are there underperforming employees that should have raises postponed  while you work with them to improve performance?
  • Are there employees already paid well above market rates that might not qualify for a raise or might have their raise postponed?
  • And perhaps most importantly, how do your overall salary levels stack up against current market salaries?  If you haven’t checked the market lately (perhaps because you didn’t grant raises), then you lack important information on competitiveness that can tell you whether you are still paying competitive rates or that a gap has opened between your organization’s salary levels and the market.

Truly effective salary planning takes into account all relevant factors – only one component of which is the amount budgeted for raises.  And knowing how your salaries stack up against the market is a critical step which Matthews, Young can help with.

So, it’s not too early to start this review.  And as we gather more intelligence on projected raises for 2011, we will get back to you.

David Jones, Principal and Executive Compensation Practice Leader

Matthews, Young – Management Consulting

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(404) 435-6993

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